Fannie Mae’s long-awaited switch to hedge accounting is about to go into effect.
If all goes well, that change will occur in the first quarter of next year, Fannie Mae Chief Financial Officer Celeste Brown said during a media call about its third-quarter earnings on Thursday.
The accounting change, and net income gains fueled in part by the rate-driven refinance boom, may help prepare the government-sponsored enterprise for
Third-quarter net income, at $4.2 billion, was up 68% on a consecutive-quarter basis from $2.5 billion and 5% year-over-year from $4 billion. Some of the gains came from the prepayments that were a product of the refi boom. Those led to a faster amortization of upfront loan-sale fees.
Fannie expects to see a relative decline in its net income for the year due to the negative impact of the coronavirus. Its forecast accounts for the challenges that are likely to remain given regional resurgences in the infection rates, and the lack of clarity regarding future government stimulus measures.
While the current forbearance rate for single-family mortgages at Fannie is just above 4%, the cumulative forbearance rate for the pandemic as it extends into 2021 is currently forecast to reach 9%, Brown said.
Hedge accounting, in line with a practice used by a growing number of public companies, does little to address concerns associated with the pandemic, but it could reduce interest-rate volatility in Fannie’s earnings.
Fannie’s smaller rival, Freddie Mac, switched to hedge accounting back in 2017 after rate swings hurt its earnings. Fannie, in contrast, decided to wait because of amendments to hedge accounting rules were pending at the time.
Without hedge accounting, Fannie’s results are more reflective of changes in rates more than its actual operational performance, so switching to it could be helpful, said Richard “Dick” Bove, senior research analyst at Odeon Capital Group.
However, Fannie and Freddie Mac would need to make a lot of other improvements to the transparency and state of their financials before Bove would consider their shares to be competitive investments, he said.
“Anything that gives you a clearer understanding is good, but in general, I think that balance sheet reporting of these companies basically does not reflect what’s going on,” he said, noting that this has been a concern since the GSEs essentially left the public markets and went into conservatorship in 2008.
Bove would like to see Fannie and Freddie’s reporting and financials brought more into line with companies in comparable industries, such as insurers.
During conservatorship, the GSEs’ regulator and conservator directed them to reduce the size of their portfolios and they primarily became guarantors. Only relatively recently has that changed, as they’ve been directed to
Fannie’s net worth as of Sept. 30 had increased to $20.7 billion from $16.5 billion the previous quarter. Its current agreement with the U.S. Treasury allows it to retain earnings until its net worth reaches $25 billion.
Bove is currently skeptical of prospects for Fannie’s common stock and considers it a “sell,” but noted that it plays a key role in the U.S. housing market that it is unlikely to be displaced from. He considers Fannie’s preferred stock to be a “buy,” but only because he thinks investors who hold these shares will eventually prevail in a lawsuit related to how their investments were affected by conservatorship.
